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ECO100 - Economic Profits & Long-Run Equilibrium

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James Pesando

ECO100: LECTURE #13 11/02/11 Firm’s SS Curve is Firm’s MC Curve (if P > AVC) P MC MR = P q* q MR = MC  q* is profit-maximizing level of output. Question: Is firm earning economic profits? To Answer: add ATC schedule  compare P to ATC LEVEL OF PROFITS TR > TC  profits  TR /Q > TC/Q  P > ATC TR = TC  breakeven  P = ATC TR < TC  loss  P < ATC Case 1: Economic Profit (P > ATC) MC ATC 25 MR = P 20 10 q Profit-maximizing output: 10 (P = MC) Profit: (P – ATC) * q = (25 -20) * 10 = 50 Case 3: Economic Loss (P < ATC) MC ATC 30 25 MR = P 10 q Economic Profit: (P – ATC) * q (25 – 30) * 10 = -50 The firm cannot choose to change its price to $30 b/c it faces a perfectly elastic supply curve Insight: At P = 25, firm produces q = 10 Case 1) Implies that P > AVC since firm chooses to produce output rather than shut down. Case 2) Equivalently, economic loss > 50 if firm shut down. EXAMPLE: HOT DOG STANDS The market for hot dog stands is perfectly competitive. The typical hot dog stand is earning economic profits. Questions: 1) What will happen to the market price of hot dogs? 2) What will happen to the number of hot dog stands? Perfect competition characterized by freedom of entry; entrepreneurs are constantly seeking economic opportunities. Economic profits  new firms enter  SS shifts to right  market price falls SS SS’ (new firms enter) P P’ DD Q When will price stop falling? Answer: when economic profits are zero and there is no incentive for firms to enter (or leave) the industry LONG RUN EQUILIBRIUM MC SS
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